Europe’s Bonds Widen Yield Gap to Treasuries on Slower Inflation

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European government bonds rose from Germany to Portugal, outperforming U.S. peers, as inflation data buoyed the case for the European Central Bank to keep monetary stimulus while the Federal Reserve prepares to raise interest rates.

Spanish bonds advanced as consumer prices in that country resumed their drop this month, after being stagnant in June. The extra yield, or spread, that investors get for holding Treasury 10-year notes instead of similar-maturity bunds widened to the most in almost two months. The Fed signaled on Wednesday that hurdles to higher borrowing costs in the U.S. have diminished.

“Inflation remains subdued in the euro region,” said Richard Kelly, head of global strategy at Toronto Dominion Bank in London. “With the downside in oil prices this month, it’s just another delay in inflation expectations. Rate divergence in the short end of U.S. and euro-zone spreads will grow.”

The yield on Germany’s 10-year bunds dropped seven basis points, or 0.07 percentage point, to 0.65 percent as of 4:35 p.m. London time, the biggest drop since July 15. The 1 percent security due in August 2025 rose 0.655 or 6.55 euros per 1,000-euro ($1,092) face amount, to 103.385. The yield on Spanish 10-year securities dropped five basis points to 1.91 percent.

German bonds extended their advance after the Financial Times reported that the International Monetary Fund’s board was told that Greece’s debt level and record of implementing reforms make it ineligible for a third bailout from the institution. The FT cited an an internal IMF memo.

Summer Lull

Italian 10-year bonds extended gains after borrowing costs dropped at a bond auction on Thursday, as investors snapped up the debt before a summer lull.

Yields on Italian 10-year debt fell eight basis points to 1.83 percent. Similar-maturity Portuguese yield dropped six basis points to 2.46 percent, dropping below 2.50 percent for the first time since May.

German consumer prices grew at an annual rate of 0.1 percent this month, the same as June, based on a calculations using a harmonized European Union method, a government report showed, in a reading that was in line with the median prediction of economists in a Bloomberg survey.

In Spain consumer prices fell 0.1 percent from a year before. The ECB’s inflation target for the euro area is just below 2 percent. Ten-year German bonds yielded 162 basis points less than their U.S. counterparts, the biggest spread since June 1, based on closing data compiled by Bloomberg.

‘Door Open’

The Fed on Wednesday expressed satisfaction with progress toward full employment. It described job gains as “solid,” and it dropped the modifier “somewhat” to describe a decline in labor market slack. Policy makers refrained from signaling the likely timing of the first rate increase since 2006.

“The Fed has left the door open for a rate hike in September,” said Chris Chapman, a London-based fixed-income trader at Manulife Asset Management, which oversees $302 billion. “The ECB has plans to continue its quantitative-easing program, while the Fed gets closer to raising rates. The Treasury-bund spread has some room to move higher.”

Inflation expectations in Europe, as implied by five-year consumer prices swap, fell below 1 percent this week for the first time since early April. It was at 1.03 percent on Thursday, compared with the average of 1.81 percent in the past 10 years.

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